07 April 2017
The Trump administration’s retreat on healthcare has called the resilience of the president’s agenda into question. Against this backdrop, Munish Singla and Yousif Mohammed look at the major components of the Trump Trade and the implications for capital markets.
The unexpected defeat and retreat by the Trump administration on healthcare has left markets at a precipice. Following a bullish equities streak that was predicated on expectations of higher economic and corporate earnings growth to be delivered through a mix of regulatory relief, comprehensive tax reform and fiscal stimulus (together forming the core of the Trump Trade), investors have started to take stock of a more complex reality. The S&P 500 has since retreated from post-election highs while the US dollar has shed much of its post-election gains.
The healthcare episode has highlighted two dynamics that will shape how the Trump agenda fares. First, despite the outward appearance of single-party control of both the White House and Congress, there are significant ideological tensions within the Republican Party, in effect constraining the President’s room for maneuver. Second, the political logic means that there is a degree of interdependence across elements of the Trump agenda that introduces some elements of path dependence and heightened execution risks.
Against this backdrop, we revisit the major components of the Trump Trade and attempt to sketch out implications for capital markets – with a particular focus on corporate issuers.
Since taking office, the Trump administration has engaged in a flurry of activities aimed at scaling back regulations enacted during the Obama years. This has ranged from appointments of industry-friendly regulators to sharp reversals such as the approval of the Keystone XL pipeline and a rollback of the Clean Power Plan. Here it is worth noting that, other than Senate approval of key nominations, major shifts were given effect through Executive Orders, thereby bypassing the need for congressional consent.
However, it remains unclear if structural regulatory relief can be achieved on issues that require legislative overhaul. While financial stocks initially rallied ahead of broader indices on hopes of a partial repeal or significant roll back of Dodd-Frank and other elements (e.g., the Fiduciary rule), chances have since dimmed that either the President or Congress will spend political capital on this fraught issue given lingering public skepticism of the Wall Street.
Comprehensive tax reform and fiscal stimulus
The baseline narrative following the election treated the topics of corporate tax reform and fiscal stimulus as discrete agenda items, with the latter seen as a key component of Trump’s campaign and therefore his mandate as president.
On the topic of corporate tax reform, the landscape has markedly changed. While the initial blueprint included a reduction of the headline tax rate, exemption for foreign subsidiary dividends from US tax and the enactment of a ‘repatriation window’ for cash held overseas, there has been no consensus on measures needed to make this reform ‘revenue neutral’.
While the Congressional leadership has proposed a ‘border adjustment tax’ to fill the gap, vocal opposition by import-dependent companies such as retailers and manufacturers have reinforced an already lukewarm position by the President. Moreover, the inability to enact the deficit reduction measures proposed in the American Health Care Act (“AHCA”) has since added to the ‘fiscal gap’ that will need to be bridged for any tax reductions to become permanent.
This in turn brings the agenda to fiscal stimulus. This is an area where the White House shares more with the Democratic Party in its enthusiasm for government-backed infrastructure spending to which traditional Republicans are either indifferent or hostile. The emerging consensus is that the President will look to pass corporate tax reform and infrastructure stimulus measures in the same legislation as part of a ‘great bargain’ with Democrats – allowing him to bypass a potentially restive GOP caucus.
In order to achieve a ‘passable legislation’ supported by mainstream Republicans, the eventual scale of any form of stimulus will likely fall far below the initial figure of up to one trillion dollars over the course of a decade, with the fiscal mix further tiled further towards tax breaks rather than direct government spending.
Implications for Issuers
Notwithstanding the twists and turns on the US political front, the landscape for issuers will continue to be shaped by cyclical drivers such as global economic growth, interest rate cycle and currency movements. Taken together, these point to a 2017 being an active year across multiple pockets of global capital markets.
In equity capital markets, strong valuations and a pent-up pipeline could be the perfect recipe for strong IPO activity. On the bonds front, expectations of accelerated rate hikes in the US prompted corporate treasurers to raise debt early to lock in lower rates. However, if a ‘repatriation holiday’ becomes a reality, a key driver behind large-scale US debt issuance – for example, US companies issuing domestic bonds ‘pledged’ by overseas cash piles - may falter on the margins. On the international front, emerging market corporates with USD financing needs will face headwinds through a combination of higher yields and a stronger USD, underpinned by domestic growth and a more hawkish US monetary policy.
M&A activity will likely be subject to different dynamics in this environment. Domestic US M&A activity may see some consolidation or opportunistic activity in select sectors. However, rising interest rates would also act as a headwind for debt-heavy acquisitions, thereby favoring cash-rich corporates over private equity acquirers.
On the other hand, the international M&A front would vary significantly given the outsized impact of US trade and economic policy on industries around the world. Attempted acquisitions of US corporates or assets may catch on a political flavor. Volumes have already suffered in the first quarter as investors took stock of the rising uncertainties.
We are beginning to see what would be a very interesting paradigm shift in the rules of economic engagement with the US. This space will remain active for some time to come.
Munish Singla is Global Head of Escrows at Deutsche Bank and Yousif Mohammed is Vice President, Trust & Agency Services at Deutsche Bank.
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Global Head of Escrows, Deutsche Bank
Vice President, Trust & Agency Services, Deutsche Bank